The FTSE 100 has surged past 6,000 to a 17-month high as a long-awaited deal to avoid the US 'fiscal cliff' sparked a relief rally across world markets.

Investors are celebrating after US politicians finally buckled under the threat of recession and agreed a deal to avoid hitting most American households with massive tax rises.

The fiscal cliff agreement, which was sealed just hours before world markets were due to reopen after the New Year holiday, also delayed a package of spending cuts which together with higher tax rates could have drained $600billion out of the US economy at once.

Budget stand-off: Democrat President Barack Obama demanded tax rises for the wealthiest Americans while opposition Republicans called for swingeing cuts to social programmes mostly benefiting the poorest

Economists feared that, without action
by Congress, the budget changes that technically took effect on New
Year's Day would cause unemployment to surge and the US economy to
contract by an estimated 4 per cent.

The FTSE 100 closed 129.6 points or 2 per cent higher at 6,027.4 - its highest level since July 2011.

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Meanwhile, the US dollar weakened against major currencies as traders moved to reverse their recent flight to the safe haven of the greenback. Sterling was among those appreciating against the dollar, with a pound now buying $1.63 on currency markets.

The US budget deal was struck after months of political wrangling in Washington, as Democrat President Barack Obama demanded tax rises for the wealthiest Americans while the opposition Republicans called for swingeing cuts to social programmes mostly benefiting the poorest.

In an unprecedented pre-dawn vote in the House of Representatives, the eventual agreement ditched tax increases for the middle classes while raising tax rates on incomes over $400,000 (£247,000) for individuals and $450,000 (£278,000) for couples.

WHAT IS IN THE FISCAL CLIFF DEAL?

Income tax rates: Extends decade-old
tax cuts on incomes up to $400,000 for individuals, $450,000 for
couples. Earnings above those amounts would be taxed at a rate of 39.6
per cent, up from the current 35 per cent. Extends Clinton-era caps on
itemized deductions and the phase-out of the personal exemption for
individuals making more than $250,000 and couples earning more than
$300,000.

Estate tax:
Estates would be taxed at a top rate of 40 percent, with the first $5
million in value exempted for individual estates and $10 million for
family estates. In 2012, such estates were subject to a top rate of 35
percent.

Capital gains,
dividends: Taxes on capital gains and dividend income exceeding $400,000
for individuals and $450,000 for families would increase from 15
percent to 20 percent.

Alternative
minimum tax: Permanently addresses the alternative minimum tax and
indexes it for inflation to prevent nearly 30 million middle and
upper-middle income taxpayers from being hit with higher tax bills
averaging almost $3,000. The tax was originally designed to ensure that
the wealthy did not avoid owing taxes by using loopholes.

Other
tax changes: Extends for five years Obama-sought expansions of the
child tax credit, earned income tax credit, and an up to $2,500 tax
credit for college tuition.

Unemployment benefits: Extends jobless benefits for the long-term unemployed for one year.

Cuts
in Medicare reimbursements to doctors: Blocks a 27 per cent cut in
Medicare payments to doctors for one year.

Social
Security payroll tax cut: Allows a 2 percentage point cut in the
payroll tax first enacted two years ago to lapse, which restores the
payroll tax to 6.2 per cent.

Across-the-board
cuts: Delays for two months $109billion worth of across-the-board
spending cuts set to start striking the Pentagon other agencies
this week.

Spending cuts were delayed but only for two months, meaning another showdown is still pending over both this and the need to raise the US debt ceiling - an agreed level of borrowing that the government is not allowed to breach without approval from Congress.

But the fiscal cliff bill's passage on a 257-167 vote was a triumph for President Obama after his re-election in November on the back of a pledge to impose higher taxes on richer Americans.

He said the measures were 'just one step in the broader effort to strengthen the economy'.

The London market has been in limbo in recent sessions as traders pondered the implications of America failing to reach a compromise to avoid the fiscal cliff.

Cantor Index analyst David Buik said: 'There was never any chance of there being anything worse than a fudged agreement on the proposed budget, including taxation increases for the better-off.

'The ramifications of no agreement were not worth considering. As it stands, the prevarication may have cost the US 0.5 per cent of GDP for 2013. No agreement at all would have cost 4 per cent of GDP.'

But Joe Rundle, head of trading at ETX Capital, warned: 'Business is unfinished as the bill voted through avoids most of the immediate pain but not the full effect of the fiscal cliff.

'Today’s bullish tone may continue as we head toward the weekend but the euphoria will most certainly evaporate as the deal voted through does not include raising the debt ceiling and longer term budget cuts.'

And he added: 'Judging by the disruptive game of brinkmanship US lawmakers played in the final weeks of 2012, markets have lost their trust in US politicians.

'The likelihood that we will see a series of setback in talks, continued political posturing and finger pointing is again set to unnerve investors, prompting huge bouts of volatility in markets.'

Louise Cooper of financial consultancy CooperCity said: 'This deal may avert the imminent crisis but postpones the critical decisions - it is a temporary plaster (or Band-Aid if you're American). Kicking the can down the road is not just a European game - the Americans are playing it too.

'Given that the new Congress coming in - the 113th - is viewed as being more partisan than the last, then a Grand Deal seems unlikely. Instead, expect a series of small compromises - Obama's "stages".

'The next will be on the debt ceiling - due to be breached in February. Senate Republicans have agreed in this deal to higher taxes for the wealthy and will therefore be adamant in demanding lower spending in the debt ceiling negotiations.'